If You’re a Bull, Root for a High-Volume Selloff

One more big loser of a day might be what this market needs to finally work toward a technical bottom

On Thursday, the Dow Jones Industrial Average fell 0.5% to its lowest level since April. The higher opening reflected the European Central Bank’s commitment to its current policy. But by mid-morning the gains vanished when the ECB warned that the current “tensions between Russia and the West pose a risk to economic recovery.”

Recently, defensive sectors have not reflected the negative mood of stock buyers. However, a more normal pattern developed yesterday with precious metals and utility stocks being bought along with U.S. Treasuries. Yesterday’s trading showed a shift to a more “risk off” situation. The 10-year note’s yield dropped to 2.415%, the lowest since June 2013.

Meanwhile, gold rose 0.3% to $1,310.80 and the dollar rose vs. the euro.

At the close, the Dow Jones was down 75 points to 16,368, the S&P 500 fell 11 points to 1910, and the Nasdaq lost 20 points, falling to 4335. The Russell 2000 fell just 6 points to 1120. The New York Stock Exchange’s primary market traded 670 million shares with total volume of 3.2 billion shares, while the Nasdaq crossed 1.8 billion shares.

On the Big Board, decliners outpaced advancers by 1.1-to-1, and on the Nasdaq, decliners led by 1.8-to-1.

Despite the S&P 500 being down about 4% from its high reached July 24, the selloff feels worse. That’s because the S&P 500 and other indices have sliced through major support zones almost without a break.

Seven of the past 10 sessions have closed lower, and two of those closed higher by less than one point. The S&P 500’s support zone (now resistance zone) at 1951 to 1925, along with its 50-day moving average, fell without a pause.

And selling has been more focused on the small caps, with the Russell 2000 falling almost 8% from its high of July 1 at 1,214 (not shown).

Conclusion

The question of when we should expect an end to this decline, I think, rests with an indicator of panic. I’m not referring to the CBOE Volatility Index (VIX), but simply downside volume. The present decline reminds me very much of the January/February decline and bottom.

Note on the left side of the S&P 500’s chart when the index fell through its 50-day moving average on Jan. 24. Volume increased to 4.6 billion shares (NYSE), and on Feb. 3, the closing low was made when volume increased to 4.7 billion shares. Average total volume before that was about 3 billion shares, and many days in December traded less than 2.5 billion shares.

Now refer to right side of the chart and penetration of the 50-day moving average on July 31. Volume spiked to 4.2 billion shares vs. an average of about 3.2 billion for the month — and again, many days traded under 2.3 billion shares. Now note the shallow consolidation following the first breakdown in January and its similarity to last week’s shallow consolidation, both shown in yellow.

I believe that one more high-volume selloff with volume in excess of 4.3 billion shares could provide the level of panic required to form a bottom. MACD is now oversold and at approximately the levels of late January.

One more high-volume day down would threaten a break of the 200-day moving average, just as it did on Feb. 3.